Macquarie :Hindustan Petroleum (HPCL) Unease on subsidies; cheap valuations; target Rs 454

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Hindustan Petroleum
Unease on subsidies; cheap valuations
Event
 HPCL announced a PAT of Rs2.1bn for Q3FY11, which was materially lower
than our estimate due to a higher-than-expected subsidy burden, and
extended CDU shutdowns. We reduce FY11-13 earnings estimates by 15-
19% on higher subsidy burden expectations due to sharply rising product
prices, and cut our TP to Rs454 (-15%). However, the Oil Marketing
Companies (OMCs) are potential safe havens in falling markets. Maintain
Outperform.

Impact
 GRMs at US$5.6/bbl; volumes down 19% YoY on Vizag shutdowns:
GRMs jumped 1.1x QoQ to US$5.6/bbl due to improving auto-fuel cracks and
high inventory gains due to HPCL’s FIFO inventory methodology. CDU-II
planned shutdown and unplanned CDU-III shutdown for vacuum heater tube
problems in the Vizag refinery restricted HPCL’s throughput to 3MMT.
 Retail sales up 11% YoY; Under-recoveries rose 39% QoQ to Rs34bn:
With auto-fuel demand growing in excess of 10% YoY, retail sales of HPCL
have risen 11% YoY to 6.5 MMT. With increased crude prices and growth in
sales, HPCL’s under-recovery YTD burden has risen to Rs23bn, despite a last
minute allocation of Rs 17.5bn by the Govt, in addition to Rs28.3bn in Q2.
 Increased under-recoveries to dampen-earnings: Crude prices have been
rising sharply, with Brent having touched US$101/bbl on the back of demand
pickup, fuelled by concerns on continuity of trade through the Middle East
(especially Egypt) due to sociopolitical unrest. High product cracks (US$ 14-
16/bbl for middle distillates Diesel, Jet-Kerosene) have further exacerbated
under-recoveries for OMCs, with Diesel margins hovering at a negative Rs7/lt.
We estimate OMCs shall bear Rs 67bn (8%) of Rs750bn expected total under
-recoveries in FY11E vs Rs56bn in FY10 (HPCL to share ~Rs12.3bn).
Earnings and target price revision
 We estimate that for every 1% increase in under-recovery share of OMCs,
HPCL’s FY11E PAT decreases ~6%. We cut FY11-13E PAT estimates by 15-
19% on the back of an increase in subsidy-sharing assumption for the Oil
marketing companies from ~5% to 8. Value of investments of HPCL has also
declined by ~Rs11/sh. Consequently, our SOTP-based TP for HPCL has
decreased to Rs454 from Rs535 earlier.
Price catalyst
 12-month price target: Rs454.00 based on a Sum of Parts methodology.
 Catalyst: Diesel price hike / deregulation
Action and recommendation
 With inflationary concerns preventing price hikes and a high fiscal deficit
raising risks of a higher subsidy share for OMCs, the stocks have already
declined 21-36% in 4 months. We see OMCs as good defensives, and HPCL
is trading at cheap valuations of 0.8x FY12E P/BV and 7.4x FY12E PER.